As we approach the end of 2023, it's a great time to review your retirement savings strategy and see where improvements can be made. This could mean reallocating funds, setting different goals, or maximizing your potential tax advantages. The less money spent on taxes, the more you have to invest or spend on whatever you please.
Part of maximizing your tax potential is using retirement accounts that provide tax breaks. You should be saving and investing for retirement regardless; you might as well get a tax break along the way. While most people associate retirement accounts with a 401(k), options like a traditional IRA can supplement your retirement plan.
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The tax benefit of a traditional IRA
IRAs can be essential to people's retirement planning and finances because of their flexibility and tax benefits. For a traditional IRA specifically, the tax benefit is immediate, with the chance for contributions to be deducted from your taxable income. This differs from a Roth IRA, where you contribute after-tax money and then take tax-free withdrawals in retirement.
The traditional IRA's tax break makes the end of the year an excellent time to make contributions, potentially reducing your tax bill when you file in early 2024. The maximum contribution for an IRA (traditional and Roth combined) for the 2023 tax year is $6,500, with an additional $1,000 catch-up contribution allowed for those age 50 or over.
Depending on your age and how much you've contributed to an IRA so far this year, making additional traditional IRA contributions could save you hundreds, if not thousands, in owed taxes in 2024. For example, imagine a single person makes $90,000 annually, and their marginal tax rate is 22%. A $6,500 contribution to a traditional IRA would reduce their taxable income to $83,500 and save $1,430 in taxes.
In tax year 2024, the maximum contributions to an IRA will increase to $7,000 for those under 50 and $8,000 for people 50 or older.
It's never too early to make contributions
Contributions to IRAs can be made for a specific tax year up until Tax Day of the following year. For instance, you have until April 15, 2024, to make your 2023 contributions. For 2024, you'll have until April 15, 2025.
Even with the extra four months to contribute to an IRA, it's best to get it out of the way earlier so you don't find yourself using the earlier parts of each year playing catch-up for the previous year's contributions.
Of course, if that's how your financial situation plays out, then by all means go for it. Any contributions, regardless of when, are better than not contributing at all.
The deduction isn't available to everyone
It's important to note that not everyone is eligible to deduct their traditional IRA contributions. Eligibility depends on several factors, including your filing status, income, and whether you or your spouse are covered by a workplace retirement plan like a 401(k) or 403(b).
The IRS uses phase-out ranges where the deductible amount gradually decreases and eventually becomes non-deductible. The phase-out ranges for 2023 and 2024 are below:
| Filing Status | Covered By Retirement Plan at Work? | 2023 Range | 2024 Range |
|---|---|---|---|
| Single | Yes | $73,000 to $83,000 | $77,000 to $87,000 |
| Married, filing jointly | Yes | $116,000 to $136,000 | $123,000 to $143,000 |
| Married, filing separately | Yes | $0 to $10,000 | $0 to $10,000 |
| Married, either filing status | No, but your spouse is | $218,000 to $228,000 | $230,000 to $240,000 |
Data source: Social Security Administration.
Even if you're not eligible for the deduction, contributing to a traditional IRA should be in your plans. It allows for tax-deferred earnings growth, so dividends and capital gains aren't taxed until withdrawal. That adds to long-term growth because you're not constantly diminishing your returns via taxes.
An IRA also comes with benefits that retirement accounts like a 401(k) don't have. There are many more investment options, they don't have as many fees, and there are more early withdrawal penalty exceptions. The relatively low contribution limit stops it from being many people's primary retirement account, but it can serve as a great supplement.
